DSGE Models of High Exchange-Rate Volatility and Low Pass-Through

48 Pages Posted: 26 Nov 2005

See all articles by Giancarlo Corsetti

Giancarlo Corsetti

University of Cambridge; University of Rome III - Department of Economics; Centre for Economic Policy Research (CEPR)

Luca Dedola

Bank of Italy; European Central Bank (ECB)

Sylvain Leduc

Federal Reserve Banks - Federal Reserve Bank of San Francisco

Multiple version iconThere are 2 versions of this paper

Date Written: November 2005

Abstract

This paper develops a quantitative, dynamic, open-economy model which endogenously generates high exchange rate volatility, whereas a low degree of pass-through stems from both nominal rigidities (in the form of local currency pricing) and price discrimination. We model real exchange rate volatility in response to real shocks by reconsidering and extending two approaches suggested by the quantitative literature (one by Backus Kehoe and Kydland [1995], the other by Chari, Kehoe and McGrattan [2003]), within a common framework with incomplete markets and segmented domestic economies. Our model accounts for a variable degree of ERPT over different horizons. In the short run, we find that a very small amount of nominal rigidities - consistent with the evidence in Bils and Klenow [2004] - lowers the elasticity of import prices at border and consumer level to 27% and 13%, respectively. Still, exchange rate depreciation worsens the terms of trade - in accord with the evidence stressed by Obstfeld and Rogoff [2000]. In the long run, exchange-rate pass-through coefficients are also below one, as a result of price discrimination. The latter is an implication of distribution services, which makes the goods demand elasticity market specific.

Keywords: International Business Cycles, exchange-rate volatility, international transmission, pass-through, DSGE models

JEL Classification: F33, F41

Suggested Citation

Corsetti, Giancarlo and Dedola, Luca and Leduc, Sylvain, DSGE Models of High Exchange-Rate Volatility and Low Pass-Through (November 2005). FRB International Finance Discussion Paper No. 845, Available at SSRN: https://ssrn.com/abstract=854184 or http://dx.doi.org/10.2139/ssrn.854184

Giancarlo Corsetti

University of Cambridge ( email )

University of Rome III - Department of Economics ( email )

via Ostiense 139
Rome, 00154
Italy
+39 06 5737 4056 (Phone)
+39 06 5737 4093 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Luca Dedola

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Sylvain Leduc (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of San Francisco ( email )

101 Market Street
San Francisco, CA 94105
United States

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